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Predatory Lending Practices in the Subprime Industry

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Predatory Lending Practices in the Subprime Industry PREPARED STATEMENT OF THE FEDERAL TRADE COMMISSION before the HOUSE COMMITTEE ON BANKING AND FINANCIAL SERVICES on Predatory Lending Practices in the Subprime Industry May 24, 2000 I. INTRODUCTION Mr. Chairman and members of the Committee: I am David Medine, Associate Director for Financial Practices, of the Federal Trade Commission's Bureau of Consumer Protection.(1) I appreciate the opportunity to appear before you today on behalf of the Commission to discuss the serious problem of abusive lending practices in the subprime lending industry, commonly known as "predatory lending." I will discuss the recent growth of the subprime industry, predatory lending practices that reportedly are occurring in the industry, the Commission's recent activities in this area, and possible statutory changes to enhance consumer protection. First, however, let me briefly speak about the Commission's role in enforcing laws that bear on these problems. The Commission has wide-ranging responsibilities concerning nearly all segments of the economy. As part of its mandate to protect consumers, the Commission enforces the Federal Trade Commission Act ("FTC Act"), which broadly prohibits unfair or deceptive acts or practices.(2) The Commission also enforces a number of laws specifically governing lending practices, including the Truth in Lending Act ("TILA"),(3) which requires disclosures and establishes certain substantive requirements in connection with consumer credit transactions, the Home Ownership and Equity Protection Act ("HOEPA"),(4) which, as part of the TILA, provides special protections for consumers in certain non-purchase, high-cost loans secured by their homes, and the Equal Credit Opportunity Act ("ECOA"),(5) which prohibits discrimination against applicants for credit on the basis of age, race, sex, or other prohibited factors. The Commission has jurisdiction over most non-bank lenders.(6) In addition to our enforcement duties, the Commission also responds to many requests for information about credit issues and consumer credit laws from consumers, industry, state law enforcement agencies, and the media.(7) We continue to see problems in the subprime industry, in particular the home equity loan business, and the Commission is working in a number of ways to address them. Commission strategies include law enforcement, often coordinated with other law enforcement officials, and consumer education. It is crucial that as many consumers as possible have access to credit, but, at the same time, this access must not be hindered by unlawful lending practices. II. THE SUBPRIME MORTGAGE INDUSTRY Subprime lending refers to the extension of credit to persons who are considered to be higher-risk borrowers, also commonly referred to as "B/C" or "nonconforming" credit.(8) Loans to subprime borrowers serve communities that may have been underserved by lenders in the past. In recent years, subprime mortgage lending has grown dramatically. In 1999 alone, subprime lenders originated over $160 billion in home equity loans.(9) This is a $35 billion increase from 1997, when subprime lenders originated $125 billion in home equity loans.(10) At the same time that subprime loans have become a significant and growing part of the home equity market, the composition of companies involved in the subprime market is evolving. One of the dramatic changes in this market has been the growth in subprime mortgage lending by large corporations, including bank holding companies, that operate nationwide.(11) The subprime mortgage market has flourished because such lending has been profitable, demand from borrowers has increased, and secondary market opportunities are growing. Lenders typically price subprime loans to consumers at rates of interest and fees higher than conventional loans. Higher rates and points can be appropriate where greater credit risks are involved, as is often the case with subprime loans. Critics assert, however, that the interest rates and fees charged by some subprime lenders are excessive, and much higher than necessary to cover increased risks, particularly since these loans are secured by the value of a home. Some attribute lenders' high rates on first mortgages in part to federal deregulation of certain state interest rate ceilings in 1980.(12) During the last five years, Wall Street investment banks have played an increasingly important role in raising funds for subprime loans. In 1995, $18.5 billion in subprime loans was securitized. In 1999, that figure reached almost $60 billion.(13) The secondary market's expansion has, in turn, helped to sustain growth in the industry by enabling lenders to raise funds on the open market to expand their subprime lending activities.(14) The government-sponsored enterprises, Fannie Mae and Freddie Mac, have begun providing a direct source of secondary market funds for certain subprime loans.(15) In addition, Fannie Mae and Freddie Mac have recently set guidelines to address concerns about predatory lending. Freddie Mac announced in February 2000 that it would not buy high-cost mortgage loans that are subject to HOEPA.(16) The following month, it announced steps to protect borrowers from predatory practices, including a refusal to purchase mortgages with single-premium credit insurance policies.(17) In April, Fannie Mae launched its own campaign against predatory lending practices. Among other things, Fannie Mae has said it will not purchase subprime loans that: include single- premium credit life insurance; charge excessive fees; charge prepayment penalties that do not benefit the borrower through, for example, a rate or fee reduction; or steer well- qualified borrowers to high-cost mortgages.(18) III. THE PROBLEM OF PREDATORY LENDING PRACTICES The enormous growth of the subprime mortgage industry has enabled many consumers to obtain home loans who previously would have had much more limited access to the credit market. The Commission is aware, however, of predatory lending practices in the subprime mortgage market that affect the most vulnerable consumers. These predatory lending practices often involve lower-income and minority borrowers.(19) Elderly homeowners, in particular, are frequent targets of some subprime home equity lenders, because they often have substantial equity in their homes, yet have fixed or declining incomes.(20) In many cases, those living in lower-income and minority neighborhoods -- where traditional banking services continue to be in short supply -- tend to turn to subprime lenders regardless of whether they would qualify for less expensive loans. While subprime lenders may expand access to credit to individuals who otherwise would be shut out of the market, unethical lenders are in a position to take advantage of consumers in the weakest bargaining position. It is critically important for consumers, especially those who live in lower-income communities, to have access to credit. However, this access should not be based on predatory lending practices that take advantage of borrowers. Predatory lending practices hide from consumers essential information they need to make decisions about their single greatest asset -- their home -- and the equity they have spent years building. Predatory lending practices are particularly devastating because these loans usually are sought at a time of great need, when borrowers are most susceptible to practices that can strip them of substantial sums of money and, ultimately, their homes. Predatory lending in the subprime mortgage market covers a wide range of practices. While the practices are quite varied, there are common traits. They generally aim either to extract excessive fees and costs from the borrower or to obtain outright the equity in the borrower's home. This is often accomplished through a combination of aggressive marketing practices, high-pressure sales tactics, and loan terms, such as prepayment penalties, that inhibit a borrower's ability to go elsewhere for credit. Among the most harmful of these practices is "equity-stripping."(21) This often begins with a loan that is based on equity in a property rather than on a borrower's ability to repay the loan -- a practice known as "asset-based lending." As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail; they frequently result in the lender acquiring the borrower's home equity. The borrower is likely to default, and then ultimately lose her home through foreclosure or by signing over the deed to the lender in lieu of foreclosure. Such a scheme is particularly damaging because these vulnerable borrowers often have no significant assets except the equity in their homes.(22) Another practice of serious concern is "packing," which is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan.(23) Lenders often stand to make significant profits from credit insurance, and therefore have strong incentives to induce consumers to buy it as part of the loan.(24) Typically, the insurance or other extra is included automatically as part of the loan package presented to the borrower at closing, and the premium is financed as part of the loan. The lender often fails to provide the borrower with prior notice about the insurance product (25) and then rushes the borrower through the closing. Sometimes, the lender represents that the insurance "comes with the loan," perhaps implying that it is free. Other times, the lender simply may include the insurance in the loan closing papers with no explanation. In such a case, the borrower may not understand that the insurance is included or exactly what extra costs this product adds to the loan. Even if the borrower understands and questions the inclusion of the insurance in the loan, subprime borrowers often are not in a position to negotiate loan terms. They often need to close the loan quickly, due to high debt, limited financial resources, and limited financing options. Therefore, they generally will not challenge the loan at closing if they believe or are told that any changes may cause a problem or delay in getting the loan.
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